Managing sales and use tax compliance getting harder for small businesses
Just staying on top of the 8,000 different state and local tax rates and a thousand changes that are made every year by state legislatures is a huge challenge for small and mid-sized business in normal times.
But confronted with the prospect of large deficits in the coming years, states are looking for more sources of revenue, are trying to expand their sales and use tax base, and are raising existing rates – all of which promises to make sales and use tax compliance even more complicated, according to Carla Yrjanson, senior director at Sabrix Tax Services, part of the Tax & Accounting business of Thomson Reuters, who recently spoke with AccountingWEB.
Some states are taxing Internet sales by companies like Amazon that have affiliates in their jurisdiction. Most are making new services and items subject to sales and use tax and are reversing exemptions.
“And these changes are cyclical. Many will be reversed when business improves,” Yrjanson said. “States are also getting aggressive in sales and use tax audits. They are hiring more auditors not just to check previous returns, but to look for businesses that are operating in the state but are not registered.”
“It is difficult and expensive for many small and mid-sized businesses to hire their own sales and use tax professionals, so many are looking for a hosted service. Businesses looking to expand into just a handful of states will be required to file a lot of tax returns. And before that process begins,” Yrjanson said, “before they even register for a business ID number, they must determine whether they have nexus in that state. States have differing definitions of nexus [physical presence]. For example, when a company makes a sale in a new state, they have to ask, what activity do I have there?”
Recently conducted nexus studies by the Sabrix Tax Services division of Thomson Reuters found that 95 percent of companies surveyed underestimated their nexus footprint, and 85 percent of participating companies underestimated the number of states they needed to register in by more than 50 percent. Businesses often do not realize that using independent contractors, performing services, or participating in a trade show can create nexus in a state, according to the study.
“Businesses have to keep track of their use taxes as well,” Yrjanson said. “They have a huge exposure either through audits or class action suits. States regularly audit businesses. Businesses purchase a lot of items not for resale and they have to self-assess their use taxes. For every item purchased, they have to ask what is this item being used for? Will it be incorporated into a product for resale for which they can file a resale certificate and not pay tax?”
The Internet sales tax law recently passed in Colorado, one effort to expand the sales and use tax base, adds a new wrinkle to an already complicated sales tax issue. Colorado will require vendors either to charge the sales tax or supply a list of Colorado destination sales on which tax is due. “At the present time,” Yrjanson said, “they haven’t said what they are going to do with the list and what is the threshold.”
A week after the bill was passed, Amazon announced that it would no longer carry affiliates in Colorado.
But Internet sales tax laws face legal challenges and may be overturned in the courts, and that is one more reason businesses might have to reverse their sales tax systems. Amazon is challenging the Internet sales tax law passed in New York, which found that online retailers with affiliates in the state had nexus. Amazon continues to carry New York affiliates, but has pulled out of North Carolina and Rhode Island, which passed similar laws.
Adding taxable items, services
Making new items and services taxable can be difficult too. “Taxes on liquor and cigarettes may have reached their limit, and states will be looking to tax other items, like candy or soft drinks,” Yrjanson said. “But they are struggling to define these items. Does candy include flour as an ingredient and, if so, how do you define a product like Twix?”
Over the past decade, the Streamlined Sales Tax Project, with 20 states as full members and three states as associate members, has been engaged in defining items that are subject to tax. The project’s goal is to assist states as they administer a simpler and more uniform sales and use tax system.
Some additional data, provided by Thomson Reuters’s Sabrix Tax Services, underscores just how complex and potentially time-consuming sales and use tax compliance can be. According to the data, to achieve compliance, the average mid-sized business with presence in all 50 states needs to:
- Research more than 13,000 taxing authorities for rates and rules, and keep updated every month
- Determine taxable status and rates across more than 13,000 tax authorities every time a new product or service is introduced
- Update systems with an average of 1,000 tax rate changes each year – most of them with little advance notice. An onerous month includes 400 to 500
- rate changes
- File 7,800 returns and process 7,800 checks to taxing authorities every year; or 650 returns and 650 checks each month; or on average prepare 22 returns and process 22 checks a day. Unfortunately, the process can't be spread out over the month and happens in three required payment periods each month.
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